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The New Landscape of Central Bank Policy Reversals

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By Balazs Koranyi and Howard Schneider

Entering a New Phase

Rapidly rising interest rates that marked a significant chapter in central bank policies are now making way for a reversal. The grand spectacle of rate hikes is being replaced by a nuanced and cautious descent into lower borrowing costs.

Unlike the bold, dramatic movements of the past, the current environment will see central banks proceeding with meticulous care, making subtle adjustments and occasional pauses. The looming threat of inflation, exacerbated by ultra-low unemployment rates, continues to cast a shadow over these impending rate cuts.

A New Normal

The trajectory for interest rates is forecasted to bottom out at levels significantly higher than the historic lows of the past decade. Dramatic shifts in the global economic landscape are poised to propel borrowing costs onto a higher trajectory for the foreseeable future.

The journey towards heightened rates commenced in late 2021 as post-pandemic challenges and soaring energy costs due to the conflict in Ukraine pushed inflation to double-digit figures worldwide. This coordinated global response effectively curbed inflation, bringing it in line with the 2% target for most major economies.

The Herald of Change

The Swiss National Bank recently made the first notable move by easing its policy with a 25 basis point rate cut. This decision not only signaled a shift in stance but also dispelled any lingering doubts about central banks waiting on the U.S. Federal Reserve before making a move.

Following suit, the European Central Bank is expected to follow in June, propelled by mounting pressure as references to this pivotal meeting become increasingly frequent.

A Calculated Approach

The Fed and the Bank of England have hinted at potential moves in the coming months, keeping their language ambiguous to allow flexibility. Investors anticipate modest cuts of 75 basis points by the end of the year, symbolizing a stark contrast to the robust rate hikes witnessed in 2022.

Moreover, projections point towards rate adjustments occurring in only three of the five scheduled meetings by year-end, hinting at possible pauses amidst the changing dynamics.

Unconventional Players

While major central banks are charting a new course, several emerging market economies, including Brazil, Mexico, Hungary, and the Czech Republic, have already initiated rate cuts. Despite their actions, the global financial stage continues to take cues predominantly from the major central banks.

A Tale of Two Economies

The U.S. economy stands out for its resilient growth, prompting the Fed to revise its projections upward. This resilience poses a conundrum for policymakers, who must navigate between supporting growth and combating stubborn inflation.

In contrast, Europe grapples with economic stagnation, with data painting a somber picture of minimal growth. The upcoming U.S. elections further complicate the Fed’s decisions, as policymakers seek to avoid any perception of political interference.

The Road Ahead

The timeline for concluding rate cuts, potentially in 2024 or 2025, remains uncertain. However, central bank officials express confidence that the ultra-low rates, some of which are negative, will not resurface.

As the world undergoes profound transformations, sparked by climate transitions, digital advancements, and geopolitical realignments, there is a growing belief that the natural rate of interest may experience a paradigm shift.

(Reporting by Balazs Koranyi in Frankfurt and Howard Schneider in Washington; Editing by Andrea Ricci)

(Balazs.Koranyi@thomsonreuters.com; +49 30 220 133 623; Reuters Messaging: balazs.koranyi.thomsonreuters.com@reuters.net)

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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